Does the fall of cryptocurrencies pose a threat to the financial system?

How big is the cryptocurrency market?

In November, The most popular cryptocurrency, Bitcoin, reached an all-time high of over $68,000, bringing the value of the cryptocurrency market to $3 trillion, according to CoinGecko. That figure was $1.51 trillion on Tuesday.

Bitcoin accounts for nearly $600 billion of that value, followed by Ethereum, with a market capitalization of $285 billion.

Although cryptocurrencies have seen explosive growth, the market is still relatively small.

US stock markets, for example, are worth $49 trillion, while the Securities and Financial Markets Industry Association has estimated the outstanding value of US fixed income markets at $52.9 trillions of dollars by the end of 2021.

Who owns and trades cryptocurrencies?

The Cryptocurrencies started out as a retail phenomenon, but institutional interest from exchanges, corporations, banks, hedge funds and mutual funds is growing rapidly.

Although data on the ratio of retail to institutional investors in the cryptocurrency market is hard to come by, Coinbase, the world’s largest cryptocurrency exchange, said that institutional and retail investors each accounted for about 50% of the crypto market. assets on its platform in the fourth quarter.

Its institutional clients traded $1.14 trillion worth of crypto in 2021, up from just $120 billion in 2020, Coinbase said.

Most of the bitcoin and ethereum in circulation is in the hands of a select few. An October report from the National Bureau of Economic Research (NBER) found that 10,000 bitcoin investors, both individuals and entities, control about a third of the bitcoin market, and 1,000 investors own approximately 3 million bitcoins. bitcoin tokens.

About 14% of Americans held investments in digital assets as of 2021, according to research from the University of Chicago.

Could a Crypto Crash Hurt the Financial System?

Although the global cryptocurrency market is relatively small, the US Federal Reserve, the Treasury Department and the International Financial Stability Board have flagged stablecoins – digital tokens pegged to the value of traditional assets – as a potential threat to financial stability.

Stablecoins are primarily used to facilitate trading of other digital assets. They are backed by assets that may lose value or become illiquid in times of market stress, while the rules and information surrounding those assets and investors’ redemption rights are confusing.

This can make stablecoins susceptible to losing investor confidence, especially during times of market stress, according to regulators.

That happened on Monday, when TerraUSD, one of the major stablecoins, broke out of its peg against the dollar and fell as low as $0.67, according to CoinGecko. That move contributed in part to Bitcoin’s decline.

Although TerraUSD maintains its peg to the dollar through an algorithm, investor runs on stablecoins holding reserves in assets such as cash or commercial paper could spill over into the traditional financial system, causing strains on those underlying asset classes. regulators say.

Regulators say that as the fortunes of companies are tied to the performance of crypto assets and traditional financial institutions are dipping deeper into the asset class, other risks are emerging.

In March, for example, Acting Comptroller of the Currency warned that banks could stumble on crypto derivatives and unhedged crypto exposures as they work with little historical price data.

However, regulators are divided on the magnitude of the threat that a cryptocurrency crisis poses to the financial system and the economy in general.

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